Challenging unjust lending through social enterprise

Archbishop Justin Welby’s commitment to ‘compete Wonga out of existence’ indicates that there are ways of challenging unjust lending through supporting alternatives as well as campaigning for regulation. In this essay, taken from the Contextual Theology Centre’s report God and the Moneylenders, the ordinand and former management consultant Philip Krinks explores the short-term credit market from a business perspective and outlines his vision for a Christian social enterprise which would offer the financially vulnerable a fair and affordable alternative to exploitative lenders.

As Selina Stone and Tom Chigbo’s essay in this collection shows, the churches in Britain have already identified the importance of improving regulation of payday lenders and of supporting the continued expansion of credit unions. I want to suggest that another practical response can be considered, to supplement and reinforce these: the creation of a new Christian social enterprise operating on a national scale. This essay will explain why such an intervention is appropriate, what it could provide and how it could be established.

Problems with the supply of credit

Problems in the short-term credit market have several causes. What is not often seen is that they result partly from the underlying economics of payday lending, and then from effects this has on the way credit is supplied.

When we speak of payday loans, we typically mean loans which have five characteristics: they are for relatively small amounts (e.g., £100-500); to fairly high risk borrowers (e.g., young adults on below average incomes); over a short term (e.g., 3-28 days); requested at short notice (e.g., on the day); to all comers (i.e., little or no need for past relationship to lender).

Most such payday loans are offered by a small number of for-profit groups working through branches and the internet, and it is their activity which is the primary focus of current public discussion and concern. Similar products are also offered by doorstep lenders, who continue to work house-to-house via agents, and of course by unlicensed informal lenders of varying levels of salubriousness.

This definition of payday loans clarifies the basic supply-side economics: the lender’s balance of revenue and costs. Compared with other lending activities, loans of this type have the potential to be unprofitable for the lender at a typical interest rate. This is because the sum of interest chargeable on each loan at any normal interest rate is very small: the loan being a small amount, and borrowed for a very short time. The operating costs in a lending business, on the other hand, are largely fixed. Furthermore, the loan default rate is high, with attendant follow-up costs, and write-offs are often in double digit percentage points. This is a basic reason that the costs to the payday borrower are so high: since the lender’s balance of revenue and costs is unprofitable at any usual interest rate, the rate charged needs to be relatively high compared to other credit products.

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“Since middle income borrowers do not borrow on a payday basis, and lower income borrowers do not have the alternatives, a gulf opens up between the two.”

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This is a problem in itself, but this initial problem also snowballs through a series of effects it has on the structure of supply of credit. An immediate effect of the high rates is that no-one will borrow in this way if they have an alternative source of credit. Those on middle or higher incomes typically do have an alternative: to borrow larger amounts, over a longer term, or secured on some asset. These are the types of finance familiar to people on middle and upper incomes, and commonly offered by banks and other mainstream finance companies: credit cards, personal loans, secured loans (for example to buy vehicles) and mortgages. All of those offer preferable economics to the lender, so draw in more credit supply, and for both those reasons offer better rates for the borrower.

Since middle income borrowers do not borrow on a payday basis, and lower income borrowers do not have the alternatives, a gulf opens up between the two products. That is reinforced by a gulf between two groups of lenders. Mainstream lenders are faced with the reputational and other issues of charging the high APRs required to make profits and following up on the relatively high number of defaulting loans. Thus, they have generally chosen to have little involvement in short-term credit products. This means that payday loans are offered by specialist lenders, which have the understanding, business model, culture and mind-set required to provide lower income borrowers with short-term credit profitably. It is aspects of this model, culture and mind-set which are currently, and rightly, being criticised.

Roles which a new social enterprise might play

Justin Welby has said he wants to ‘compete Wonga out of business’

This supply structure among, and gulf between, for-profit lenders makes it essential for ethical suppliers of credit to enter the market. However, it has proved difficult for ethical suppliers to offer short-term credit in a financially sustainable way to lower income customers. Credit unions, discussed in the next paper, offer important services, yet historically have been limited in their ability to make short-term loans by their low interest rate cap. Other providers also exist, generally offering a combination of financial advice, debt restructuring and medium-term cash loans. Examples of providers playing a valuable role include Moneyline expanding from East Lancashire, Fair Finance in East London and Scotcash in Glasgow.

The supply structure also provides a reason why the provision of financial coaching, counselling and education is crucial. Those considering such short-term borrowing, from any lender, but especially from the for-profit lenders, need these opportunities. They need to understand their situation, the reasons for it, the choices they have and the consequences of making these choices, as clearly as possible. Christian and other charities are doing important work in this area.

A new Christian social enterprise could set itself the mission of going further than existing alternatives, whilst still respecting and reinforcing them. It could offer an integrated set of three services. Firstly, a national not-for-profit short- and medium-term lending service. Secondly, signposting for lower income adults to long-term solutions to credit dependency: especially to active membership in the credit union sector and to financial coaching, counselling and education. Thirdly, for the churches ongoing prayerful reflection on, and experience in, the world of personal finance.

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“It essential for ethical suppliers of credit to enter the market. However, it has proved difficult for ethical suppliers to offer short-term credit in a financially sustainable way to lower income customers.”

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The logic for Christians to engage with the issue of payday borrowing does not need restating: it has already emerged in the other papers in God and the Moneylenders.[1] The logic for the social enterprise style of engagement suggested here, building on an important recent article by Francis Davis, is two-fold.[2] It is partly that this engagement would be effective, with a direct impact on payday borrowing, by reducing its cost and extent. And it is also that, by creating structures which are distinct from but connected to the credit union movement, it would expand the coalition of those working against exploitative lending and so help to realise a gospel vision of love, liberation and empowerment. By offering these services on a not-for-profit basis, it could open up new options for low income adults, protect them from exploitative lenders and point them onwards to other beneficial services and habits.

The logic for integrating this set of activities in a single enterprise is similar to the rationale for supporting credit union expansion: that there is a need for supply-side interventions, to expand access to lower cost sources of credit, but this supply needs to be linked to demand-side working on saving and money management.

Establishing such an enterprise

Some work has begun to define what would be needed to realise this vision of establishing a new Christian social enterprise. There are at least three requirements. The most important requirement is passionate people: those committed to serve the needs of lower income adults and to work with them and their contexts – and not only as one might ideally wish those contexts to be, but as they are and as what they can feasibly become. The second is financial resources, in the forms both of philanthropic support and social investment and finance. The third is partnerships: with organisations which already provide ethical loans, payments and banking services, including banks and credit unions; with technology and enterprise development companies; and with organisations which already provide financial coaching, counselling and education.

For those who commit to it, realising this vision will be a large undertaking. Not unrelatedly, the scale of the opportunity to free lower income adults in the UK from exploitative lending and engage them in relationships of genuine love and mutuality is also large.

Such a transformation, and the liberation and empowerment it promises, might appear limited to the financial sphere of people’s lives. In reality, they would unlock energy and potential much more broadly. The suggestion offered here, in humility, is that setting up a new social enterprise to offer these services in an integrated way would be, like the responses which Christians are already making, an act of love. It would be an act of practical love, and appropriate to those following the one who came not to be served, but to serve.

Philip Krinks is an ethicist, and a Research Associate at the Contextual Theology Centre. A former management consultant, he is now training for ordained ministry in the Church of England.

[2] See Francis Davis’s article on Public Spirit and for Conservative Home: http://www.conservativehome.com/platform/2013/07/it-is-not-surprising-that-archbishop-justin-welby-believes-that-the-terms-of-the-high-margin-high-risk-pay-day-loan-sector-c.html

The image of Justin Welby is included courtesy of the Foreign and Commonwealth Office.